Business Context and Reporting Period
MSC Industrial Direct Co., Inc. is a North American distributor of metalworking and maintenance, repair and operations products and services. The unaudited Form 10-Q covers the thirteen and thirty-nine weeks ended June 3, 2017, compared with May 28, 2016. Fiscal 2017 is a 52-week year ending September 2, 2017; the prior fiscal year had 53 weeks.
- Approximately 67% of third-quarter revenue came from manufacturing customers.
- The company offered approximately 1.545 million active SKUs through catalogs, eCommerce, inventory-management solutions, call centers and branches.
- eCommerce platforms represented 60.5% of third-quarter sales, compared with 58.6% in the prior-year quarter.
Key Financial Metrics
| Metric | Q3 FY2017 | Q3 FY2016 | Change |
|---|
| Net sales | $743.9 million | $727.5 million | 2.3% increase |
| Gross profit | $329.5 million | $327.0 million | 0.8% increase |
| Gross margin | 44.3% | 45.0% | Down 70 basis points |
| Operating income | $101.8 million | $105.8 million | 3.8% decrease |
| Operating margin | 13.7% | 14.5% | Down 80 basis points |
| Net income | $62.8 million | $64.8 million | 3.1% decrease |
| Diluted EPS | $1.09 | $1.05 | Increase |
| Metric | 39 Weeks FY2017 | 39 Weeks FY2016 | Change |
|---|
| Net sales | $2.134 billion | $2.118 billion | 0.7% increase |
| Gross margin | 44.6% | 45.1% | Down 50 basis points |
| Operating income | $279.0 million | $276.7 million | 0.8% increase |
| Operating margin | 13.1% | 13.1% | Flat |
| Net income | $170.7 million | $169.4 million | 0.8% increase |
| Diluted EPS | $2.98 | $2.75 | Increase |
- Third-quarter effective tax rate was 36.3%, compared with 38.2%; the decrease primarily reflected a research and development tax credit.
- Year-to-date effective tax rate was 36.8%, compared with 38.2%, reflecting the R&D credit and adoption of ASU 2016-09.
- Cash dividends declared were $0.45 per share in the quarter and $1.35 per share year to date.
- Year-to-date operating cash flow was $159.1 million, down from $285.8 million, primarily because of increased accounts receivable and inventories.
- Year-to-date capital expenditures were $37.9 million, compared with $34.7 million.
- Cash and cash equivalents were $27.6 million at June 3, 2017, compared with $52.9 million at September 3, 2016.
- Total debt was $515.1 million, down from $606.8 million; net debt was $487.6 million, down from $553.9 million.
- Working capital was $455.0 million and the current ratio was 1.9 at June 3, 2017.
Material Changes Versus the Prior Comparable Period
- Quarterly sales growth reflected approximately $36.3 million of higher volume, partly offset by $11.2 million from the prior year’s extra day, $6.8 million of pricing and mix reductions, and $1.9 million of unfavorable foreign exchange.
- Large Account Customer sales increased approximately $13.4 million in the quarter and $19.5 million year to date. These sales, together with vending-program growth, typically carry lower gross margins.
- Operating expenses increased 2.9% in the quarter, driven by volume-related expenses, higher incentive compensation accruals and sales commissions. Year-to-date operating expenses decreased 0.6%, providing approximately 40 basis points of expense leverage.
- Quarterly earnings pressure resulted from lower gross margin, higher operating expenses and higher interest expense. Interest expense increased to $3.4 million from $1.2 million in the quarter and to $9.2 million from $4.1 million year to date.
- Weighted-average diluted shares declined to 57.3 million from 61.4 million in the quarter, contributing to the increase in diluted EPS despite lower net income.
- The company completed an upgrade of its core financial systems in April 2017, resulting in related changes to internal control processes.
Guidance, Outlook, Risks and Unusual Items
- No specific numerical revenue, earnings or margin guidance is provided in the filing.
- Management stated that the business environment was expanding: the Metalworking Business Index averaged 56.1 in the quarter and 51.1 over the trailing twelve months. The filing notes growth in new orders, production, backlog and pricing, while stating that economic conditions will continue to be monitored.
- Management believes existing cash, operating cash flow and available revolver capacity will fund planned capital expenditures and operating requirements for at least the next twelve months.
- In April 2017, the company entered into a new $600 million unsecured revolving credit facility maturing April 14, 2022. The weighted-average borrowing rate on outstanding facility borrowings was 2.12% at June 3, 2017. The company reported compliance with its debt covenants.
- The company disclosed $338.0 million of unused credit capacity after additional June repayments of $52.0 million, net of borrowings.
- Debt agreements require a maximum consolidated leverage ratio of 3.00 to 1.00, or temporarily 3.50 to 1.00 after a qualifying material acquisition, and a minimum interest coverage ratio of 3.00 to 1.00.
- Principal risks include economic and manufacturing conditions, pricing competition, customer and product mix, commodity and energy volatility, customer credit risk, order cancellations, supply-chain disruptions, information-system failures and cyberattacks, key-person dependence, regulatory and litigation matters, acquisition integration, goodwill impairment and financing restrictions.
- Various claims and lawsuits are pending; management does not expect them to have a material adverse effect on financial position, results of operations or liquidity.
- The company adopted ASU 2016-09 for share-based payments and ASU 2015-17 for deferred-tax classification. The latter reclassified $46.6 million from current deferred-tax assets to long-term liabilities.
Important Facts for Investors to Verify
- Whether volume growth can offset ongoing pricing pressure, unfavorable mix and lower-margin Large Account Customer and vending sales.
- Whether working-capital investment in receivables and inventories normalizes, allowing operating cash flow to recover.
- The company’s leverage, interest coverage and available borrowing capacity under the new credit facility.
- The sustainability of earnings-per-share growth given lower net income and reduced share count.
- The effect of the completed financial-system upgrade on internal controls and reporting processes.
- Future manufacturing activity, foreign-exchange movements, customer credit quality and supply-chain conditions.
- The filing’s statement that operations for the first 39 weeks are not necessarily indicative of full-year results.
